The IBC requires some cleaning up

Questions persist on the legal standard that insolvency professionals - particularly those who replace the authority of the boards of directors of insolvent companies - must follow

It is insolvency and bankruptcy season. Be it the first several pages of business newspapers or the cause lists of company law tribunals, the appellate tribunal and the Supreme Court benches hearing these matters, the Insolvency and Bankruptcy Code, 2016, is hogging the limelight.  
 

Interpretation of the new law that is almost two years old is maturing with a slew of orders from the Supreme Court clarifying various nuances and steadily reducing the uncertainty over the multiple questions that adversarial litigation would obviously throw up. The season of attempts at resolution plans will eventually come to a close in a few months, and then the inevitable journey to liquidation will follow for those who have not been resolved. 
 

It is time to take stock and review how the law has performed and what needs to be done to clean things up. The Insolvency and Bankruptcy Board of India (IBBI) has its task cut out in creating a professional class of insolvency professionals. Questions loom large on the legal standard that these professionals must follow, particularly those who replace the very authority of the boards of directors of insolvent companies. For example, the insolvency professional gets vested with the authority to run an insolvent company to the exclusion of the board of directors. However, when he runs the business (incidentally, no litigation against the company would lie since an insolvent would be protected by a moratorium that could last nine months), there is no clarity on the legal liabilities and obligations that need to be discharged. These need to be addressed — examples abound.
 

First, let’s say an insolvency professional is running a company that handles hazardous substance (like a Union Carbide), and a massive environmental tragedy takes place like it did in Bhopal in the 1980s. Would the defunct Board of Directors be liable or would the insolvency professional be liable? Would the provision of insurance coverage to such a company be covered by the mandatory continuance of essential utilities in the teeth of the moratorium that would prevent litigation to recover dues from the insolvent? These questions have no answers yet, and one seems to be waiting for judge-made laws to fill in the gaps.

Second, take the insolvency professional’s own approach to running an insolvent company pending exploration of a resolution process. What is her fiduciary duty to shareholders, creditors and stakeholders? Are decisions that are evidently negligent or reckless, or even worse, partisan, to be excused? Would a moratorium against the company afford protection to the resolution professional even if evidence of malpractice can be brought to bear? The degree of subjectivity in evaluation of resolution applicants continues to remain high. Some simple and evident resolutions of conflicts among resolution applicants such as conduct of a time-bound online auction that can be completed within hours, are not resorted to. The liability of resolution professionals in taking decisions remains an unaddressed area for the outcome. It is no solace to say that the IBBI can act against her punitively — it would be like saying a stock broker can cheat investors and the only recourse is for the capital market regulator to punish him.

Illustration by Ajaya Mohanty

Third, all laws are always drafted with a presumption of bonafides. There is an even bigger presumption of lenders’ actions being bonafide. Now, if that trust is belied, is there a fiduciary duty owed by the lenders to stakeholders, for their conduct to be judged?  Committees of Creditors, the forum comprising the financial creditors can easily seek and obtain a rent for the position of power and decision-making they occupy. For example, in a technical insolvency (say a case of illiquidity rather than of insolvency), where literally no financial creditor takes a hair-cut on his entitlement to recover, would the resolution not take the form of an equity M&A transaction? Worldwide, bankers have not covered themselves in glory in the past 10 years, and the presumption of bonafides on their part, while vital, also requires checks and balances.
 

Fourth, the stigmatising of insolvency is the biggest threat to the long-term future of this law. It is one who is experienced with business failure that can work out solutions to deal with failure. By outlawing participation by anyone associated with any failure anywhere in the world, the new law has been struck a serious blow. The government’s intervention through a sweeping hasty and ill-conceived Presidential Ordinance late last year, passed into formal law without much debate early this year, stigmatising anyone with a history of business insolvency, is now the centre for a bulk of the litigation action. This column has written about it in the past and will therefore not repeat the arguments here. In an election year, getting this reversed may be a pipe dream, for politically, the tone in society has become too high-pitched for any politician to risk being seen as helping loan defaulters.
 

Finally, the infrastructure for the tribunals that handle these matters remains under strain. Members of the tribunals are working odd hours and are having to focus on the disposal of cases rather than on laying down quality jurisprudence. The only silver lining is that since the track of litigation is through the tribunal system and not the regular courts, the cases reach the Supreme Court much earlier than usual. Be that as it may, the system is creaking at the seams, and something has got to give that could threaten the very capacity of the state to deliver on the rule of law.
 

The central investigating agencies are licking their chops to get a slice of the action. The pressure to treat insolvency professionals as “public servants” is gradually mounting. If a purely private sector bank that is majority-owned by foreign shareholders can be made amenable to the jurisdiction of central investigating agencies, this front may present an easy battle for them to win. It is indeed time to contemplate on the next five years for this law, although it is only recently that a committee to amend the law has given its recommendations.

The author is an advocate and independent counsel. Tweets @SomasekharS